The Multistate Tax Implications of a Mobile Workforce

By:
Mark Klein and Emma Savino
Published Date:
Mar 1, 2020

In 2019, Americans took an estimated 470 million domestic business trips, and spent more than $327 billion on business travel, which has increased year after year. In fact, global business travel is forecasted to increase by 6.9% in 2020. Surveys suggest that 85% of companies have employees who work outside their resident jurisdiction—and more employees are travelling away from their home business location than ever before.

But travel is not the only reason employees are not working at their home business location. Many employers are now offering the option to telecommute, and more than 3% of the U.S. workforce now works from home at least half the time. While this percentage may seem small, it has increased by 173% since 2005 and will likely continue to increase as employers see the its potential cost-saving benefits.

What employers often do not realize or fully appreciate is that by requiring their employees to travel for business, as well as allowing employees to telecommute, they may create multistate tax compliance issues. And as states become more aggressive in their pursuit of new ways to increase tax revenues, out-of-state companies become easy targets. In New York, for example, auditors strictly scrutinize the travel and entertainment expenses of multinational company employees who may occasionally visit New York on business. Are these executives paying income taxes to all the states they visit? Are their employers withholding income taxes? Are these companies collecting any sales tax on sales of their products?

With hundreds of billions of dollars being spent on business travel and employers increasingly offering the option of telecommuting, states will only become more aggressive in their enforcement. Consequently, employers need to be aware of the range of state tax obligations for which they are responsible, including not only sales tax, but also business and withholding taxes.

Nexus

When thinking about multistate tax responsibilities, the first step is always determining whether the company has nexus with a state. The term “nexus” generally refers to the nature and frequency of contacts that an out-of-state company must establish in a state before it becomes subject to that state’s tax laws and jurisdiction. Under the U.S. Constitution, there must be “some definite link, some minimum connection between a state and the person, property, or transaction it seeks to tax.” (Miller Brothers Co. v. Maryland)

To be constitutional, a state may only tax a company that has such minimum contacts to the taxing state so that imposing the tax would not burden interstate commerce. The U.S. Supreme Court has laid out a four-prong test to determine whether a state tax is constitutional. The first prong of the test requires “substantial nexus” with taxing state. What is considered substantial nexus is not always straightforward, but in general, a minimal connection is all that it takes to allow a state to impose its tax responsibilities.

Sales Tax

For sales and use tax purposes, the historic rule was that, at a minimum, some form of physical presence was needed before an out-of-state company had nexus with a state. That changed in 2018 with the U.S. Supreme Court decision in South Dakota v. Wayfair. And while the impact of that decision is outside the scope of this article, it is very clear that temporary presence in a state by even a single employee, representative, independent contractor, or other agent can give rise to sales tax nexus and, thus, a collection and remittance obligation.

While physical presence nexus rules still exist, the rules have also been expanded to include “economic nexus.” Now out-of-state companies without a physical presence in a state can be required to collect and remit sales and use taxes if they surpass either—

  • an annual dollar threshold (generally $100,000 or $200,000 in total sales), or
  • an annual transaction threshold (generally 100 or 200 separate sales transactions).

Most states have now adopted economic nexus rules alongside their existing physical presence nexus rules.

Business Taxes

Not only have most states adopted economic nexus rules for sales and use tax purposes, but some, such as Hawaii and Pennsylvania, have also begun to impose similar economic nexus thresholds for income and corporate tax purposes. Even more states—including Texas, Ohio, and Washington—impose some kind of economic nexus for gross receipts tax purposes.

There is one piece of good news, however. The ability of a state to impose income tax on an out-of-state company is limited by Public Law 86-272, which prevents states from imposing net-income taxes on an out-of-state company if the company’s only activities in the state are restricted to the “mere solicitation” of sales of tangible personal property, and the orders are sent outside of the state for approval and fulfillment. Mere solicitation includes a number of protected activities including, for example, the following:

  • Soliciting of orders by an in-state resident employee or representative of the company, as long as such person uses an entirely non-public “in-home” office.
  • Providing automobiles to sales personnel for their use in conducting protected activities.
  • Owning, leasing, using or maintaining personal property for use in the employee or representative’s “in-home” office.

On the other hand, Public Law 86-272 does not afford protection to anything viewed as beyond the scope of solicitation, such as repairs, collection activities, and management of customer complaints.

Public Law 86-272 trumps state law, but it is important to be aware of its very limited application. While it applies to the solicitation of sales of tangible personal property, it does not typically apply to the sales of services or digital products. Furthermore, Public Law 86-272 only applies to net-income taxes, and thus it does not apply to sales and use tax or gross receipts taxes, such as the Ohio Commercial Activity Tax, Washington Business & Occupation Tax, or Texas Franchise Tax. Nor does it affect an employer’s responsibility to withhold income tax, pay unemployment tax and disability insurance, and cover workers’ compensation.

Employer Withholding

In general, states require employers to withhold personal income taxes on behalf of their traveling employees. Currently, 41 states impose a personal income tax. Two states, New Hampshire and Tennessee, only tax income from intangibles. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not impose any income tax. Therefore, an employer with either employees who travel or telecommute should be familiar with the rules in each of the 41 states where it has an employee or where an employee will travel.

This is no easy task—withholding requirements differ widely among states. A number of states have no thresholds, so employers are technically required to withhold state taxes on the first dollar earned or the first day worked in the state. These states include Colorado, Indiana, Massachusetts, Maryland, Michigan, North Carolina, Ohio, Pennsylvania, and Virginia. Another 20 states only require withholding when the employee has reached a specific income threshold, and the thresholds range from $300 to more than $10,000.

Many states require an employer to begin withholding personal income taxes on employee wages on the first day of employee business travel into that state. In these states, including Colorado, Massachusetts, North Carolina, Ohio, and Virginia, the employer is responsible for withholding, no matter how short an employee’s stay or how little the amount of income. A number of states require employers to withhold state taxes on the nonresident employee’s income after the employee spends a certain number of days within the state, and the number of days varies in each state. For example, in Connecticut and New York, the employer must withhold taxes on nonresident employee income after the employee spends more than 14days within the state. Arizona, on the other hand, does not require withholding until the nonresident employee has spent more than 60 days in the state. Often the requirements are based not only on income but also on number of days, which makes compliance for the employer even more complicated.

Employers must also consider whether reciprocal agreements exist between the employee’s resident and nonresident states. Reciprocal agreements are agreements between two states that allow the residents of each state to claim an exemption from withholding tax in the other state. For example, if an employee works in State A but lives in State B, a reciprocal tax agreement between State A and State B may provide that the employer need only withhold for, and the employee need only file in, State B. However, reciprocal tax agreements typically exist only between neighboring states, and not all neighboring states have them (e.g., New York and New Jersey do not have such an agreement, while Pennsylvania and New Jersey do). Notably, reciprocal agreements do not apply to local taxing jurisdictions.

Telecommuting Employees

Having employees telecommute can seem like a cost-saving measure, but it can also create nexus for an employer for withholding, sales and use, and business taxes. This is because a telecommuting employee represents an in-state presence for employers. By having an employee in-state, almost every state would determine that the employer has sales and use tax nexus as it will be physically present in that state, as explained above. Further, nexus may be triggered for the employer by “doing business” or “transacting business” in-state because the employer maintains an office, owns or leases property, or has employees performing services for the employer in-state.

Some states, such as Illinois, New Jersey, and Ohio, have determined that the presence of a telecommuter is a sufficient connection to require the business to file income tax returns. Indiana, Kentucky, Mississippi, Oklahoma, and Maryland (depending on the in-state activities) have stated that having one to six employees telecommuting from their home and conducting non-solicitation activities would not establish nexus for corporate income tax purposes.

Not only can a telecommuting employee create nexus for the employer, it can also result in personal income tax nexus and withholding requirements, as described above. As a resident of a state, an employee is subject to tax on all income in the resident state; however, if an employee is telecommuting from a nonresident state, she may be subject to tax on her income sourced to that state.

If the employer is located in Connecticut, New York, Delaware, New Jersey, Nebraska, or Pennsylvania and it has telecommuting employees, it must also be aware of the so-called ‘‘convenience rule.’’ Under this rule, if an employer is located in State A, the days worked from home are still treated as work days in State A unless the nonresident employee worked outside of State A by necessity because he could not provide those services elsewhere. For example, if the employer is located in New York and the employee is based out of or reports to that office, New York treats the employee as if he is physically working in that office for withholding tax (and personal income tax) purposes, even though he is actually telecommuting from a home office in California. Thus, New York would require the employer to withhold New York taxes from that employee. California could also treat those same wages as subject to California withholding and taxation. It should be noted that this rule only applies to nonresident employees and not independent contractors.

A Potential Solution

Clearly, there is no simple way for an employer to comply with all of the relevant multistate withholding tax requirements, and the U.S. Senate acknowledged this with its proposed Mobile Workforce and State Income Tax Simplification Act of 2019. This bill would establish a 30-day threshold before a state could impose income tax on a nonresident employee’s wages. Thus, if an employee worked more than 30 days in a nonresident state, she would have to file income tax returns there, and the employer would be required to withhold state taxes. But if the employee worked 30 days or fewer in a nonresident state, she would remain fully taxable in her resident state on all earnings. However, the 30-day requirement would not apply to professional athletes, professional entertainers, or certain national figures who are paid on a per-event basis to give speeches or similar presentations.

The employer would be permitted to rely on the employee’s determination of the number of days spent in a nonresident state, absent knowledge of employee fraud or collusion between the employer and employee. But if an employer maintains a time-and-attendance system at its discretion, and it tracks where employees perform their services, then the system must be utilized instead of the employee’s determination.

Passage of this bill is by no means ensured. In the meantime, employers should consider utilizing a compliance worksheet that includes such items as the number of employees in the state, time spent in the state, total compensation, state rule (including relevant thresholds), and whether a reciprocal agreement applies.

Next Steps

Multistate tax compliance is not simple, whether it is related to sales and use, business, or withholding taxes. However, as employers continue to offer telecommuting options and increase the number of employees travelling for work, it is vital that employers are aware of  and address their multistate tax compliance issues.

 


Mark Klein is chairman of Hodgson Russ and concentrates his practice in New York State and New York City tax matters. He has more than 35 years of experience with federal, multistate, state and local taxation -- and may be best known for his public speaking on tax topics. Mark splits his time between the Firm's New York City and Buffalo offices.

Mark has represented numerous Fortune 500 companies in connection with corporate, withholding and sales tax audits as well as dozens of individuals who appear on the Forbes 500 list of wealthiest individuals in the United States in connection with New York income tax inquiries. Mark taught courses in the tax certificate program in the school of management at the University of Buffalo on state taxation and tax practice and procedure. He is a member of The CPA Journal editorial review board and has written numerous books, articles and treatises on the subject of multistate taxation. 

Emma Savino is an associate in the state and local tax practice. She handles disputes involving the New York State and City Tax Departments and counsels businesses and individuals in a range of multistate, state and local tax issues. She advises clients on all aspects of state and local tax from planning and compliance, to audit and litigation.

Prior to joining Hodgson Russ, Emma served as a volunteer law clerk for United States District Judge William Skretny of the Western District of New York. She was also employed as a law clerk at a local firm for nearly two years. Prior to attending law school, Emma worked for TJX Canada as an allocation analyst.

 
Views expressed in articles published in Tax Stringer are the authors' only and are not to be attributed to the publication, its editors, the NYSSCPA or FAE, or their directors, officers, or employees, unless expressly so stated. Articles contain information believed by the authors to be accurate, but the publisher, editors and authors are not engaged in redering legal, accounting or other professional services. If specific professional advice or assistance is required, the services of a competent professional should be sought.